WILLIAMS SONOMA INC (WSM) FY 2023 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 52 weeks ended January 29, 2023 (“fiscal 2022”), and the 52 weeks ended January 30, 2022 (“fiscal 2021”) should be read in conjunction with our Consolidated Financial Statements and notes thereto. All explanations of changes in operational results are discussed in order of magnitude.

A discussion and analysis of our financial condition, results of operations, and liquidity and capital resources for the 52 weeks ended January 30, 2022 (“fiscal 2021”), compared to the 52 weeks ended January 31, 2021 (“fiscal 2020”), can be found under Item 7 in our Annual Report on Form 10-K for fiscal 2021, filed with the SEC on March 28, 2022, which is available on the SEC’s website at www.sec.gov and under the Financial Reports section of our Investor Relations website.

OVERVIEW

Williams-Sonoma, Inc. is a specialty retailer of high-quality sustainable products for the home. Our products, representing distinct merchandise strategies — Williams Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Teen, West Elm, Williams Sonoma Home, Rejuvenation, and Mark and Graham — are marketed through e-commerce websites, direct-mail catalogs and retail stores. These brands are also part of The Key Rewards, our loyalty and credit card program that offers members exclusive benefits across the Williams-Sonoma family of brands. We operate in the U.S., Puerto Rico, Canada, Australia and the United Kingdom, offer international shipping to customers worldwide, and have unaffiliated franchisees that operate stores in the Middle East, the Philippines, Mexico, South Korea and India, as well as e-commerce websites in certain locations. We are also proud to be a leader in our industry with our Environmental, Social and Governance (“ESG”) efforts.

During fiscal 2021 and continuing through fiscal 2022, global supply chain disruptions, including COVID-19 related factory closures and increased port congestion, caused delays in inventory receipts and backorder delays, increased raw material costs, and higher shipping-related charges. We expect the impact of higher product costs, ocean freight, detention and demurrage to continue into fiscal 2023, which could negatively impact our business.

Fiscal 2022 Financial Results

Net revenues in fiscal 2022 increased $428.5 million, or 5.2%, with company comparable brand revenue ("company comp") growth of 6.5%. This was driven by strong order fulfillment and growth initiatives. On a two-year basis, company comp growth was 28.5%. Pottery Barn, our largest brand, delivered 14.9% comparable brand revenue ("brand comp") growth driven by our growth initiatives such as our accessible home, apartment and our market-place assortment. On a 3-year basis, Pottery Barn delivered 54.0% brand comp growth. In West Elm, brand comp growth was 2.5% with strong operating margins, on top of 33.1% brand comp growth the prior year, resulting in a 35.6% brand comp growth on a two-year basis. On a 3-year basis West Elm generated 50.8% brand comp growth. West Elm is our brand most affected by the current tough macroeconomic environment. Our Williams Sonoma brand had a brand comp decrease of 1.7% as we continued recovery in our in-stock inventory position and increased our focus on product exclusivity and innovation. On a 3-year basis, Williams Sonoma generated 32.6% brand comp growth. In our Pottery Barn Kids and Teen businesses, we saw brand comp growth of 0.4% driven by growth in baby and dorm as in-stock inventory improved. Finally, our emerging brands, Rejuvenation and Mark and Graham, combined, delivered 9.6% brand comp growth.

We ended the year with a cash balance of $367.3 million and generated positive operating cash flow of $1.1 billion. In addition to our strong cash balance, we also ended the year with no outstanding borrowings under our revolving line of credit. This strong liquidity position allowed us to fund the operations of the business by investing $354.1 million in capital expenditures during fiscal 2022, and to provide shareholder returns of approximately $1.1 billion in fiscal 2022 through share repurchases and dividends.

In fiscal 2022, diluted earnings per share was $16.32 (which included a $0.21 impact from the impairment of Aperture, a division of our Outward, Inc. subsidiary) versus $14.75 in fiscal 2021 (which included a $0.10 impact from acquisition-related expenses of Outward, Inc.).

Our three key differentiators - our in-house design, our digital-first channel strategy, and our values - continued to distinguish us as the world’s largest digital-first, design-led and sustainable home retailer. Our in-house design capabilities and vertically integrated sourcing organization allow us to deliver high-quality, sustainable products at competitive prices. Through our e-commerce platform, our in-house customer relationship management and data analytic teams optimize our digital spend and customer connections. Our stores serve as design centers and omni-fulfillment hubs.

Along with our key differentiators, our success and profitability are driven by our growth initiatives that are cross-brand and/or outside of our core brands. Our largest cross-brand growth driver is business-to-business, which positions us to furnish our customers everywhere - from restaurants to hotels, from football stadiums to office spaces.

Another successful growth initiative is our expansion into global markets. We have expanded our franchise business into India with an exclusive and differentiated product line, and our three stores and websites are outperforming our expectations in a market where we

28

Table of Contents

see tremendous opportunity. In Canada, we relaunched our websites and saw improvements in conversion and average unit retail across brands.

Our emerging brands, Rejuvenation and Mark and Graham, have also provided incremental growth. These two brands service the white space needs of customers. At Rejuvenation, we’re expanding into remodel categories related to kitchen and bathroom, including vanities, cabinet hardware and custom wall lighting. At Mark and Graham, our high-quality gift and personalization business is resonating with our customers, and we saw outsized growth in the travel space including luggage and accessories.

As a digital-first company, we are in continuous pursuit of incremental improvement to our customers’ shopping journey online. We have improved several product-finding and purchasing experiences on our websites, including improved room styling, native registry applications, and the removal of friction in the checkout process. Additionally, we are focused on continued optimization and automation in our distribution centers and logistics networks to improve our service times.

On the sustainability front, we take great pride in the progress we are making within our impact initiatives and ESG leadership across the home furnishings industry. These commitments are reflected in the high quality, durable, sustainable products that we offer our customers, and continues to distinguish our company and our brands.

Looking Ahead to 2023

As we look forward to the year ahead, we believe our key differentiators – our in-house design, our digital-first channel strategy, and our values, our growth initiatives and our unique operating model will set us apart from our competition and allow us to drive long-term growth and profitability. However, the current uncertain macroeconomic environment with the weak housing market, layoffs, inflationary pressure and possible recession may impact our results. Additionally, we continue to experience increased costs across our global supply chain, including higher product costs, higher freight and incremental distribution center costs for additional space to support our overall growth. It is hard to predict with certainty when these supply chain and macroeconomic challenges will be fully resolved and we currently expect these challenges to negatively impact our results into fiscal 2023. In the back half of fiscal 2023, we believe these gross margin pressures may become tailwinds that support our profitability. Despite these challenges, we believe our key differentiators, our growth initiatives and our unique operating model leave us well-positioned to mitigate these challenges in both the short- and long- term. For information on risks, please see “Risk Factors” in Part I, Item 1A.

29

Table of Contents

Results of Operations

NET REVENUES

Net revenues consist of sales of merchandise to our customers through our e-commerce websites, retail stores and direct-mail catalogs, and include shipping fees received from customers for delivery of merchandise to their homes. Our revenues also include sales to our business-to-business customers and franchisees, incentives received from credit card issuers in connection with our private label and co-branded credit cards, and breakage income related to our stored-value cards.

Net revenues in fiscal 2022 increased $428.5 million, or 5.2%, with company comp growth of 6.5%. This was driven by strong order fulfillment and growth initiatives. On a two-year basis, company comp increased 28.5%.

The following table summarizes our net revenues by brand for fiscal 2022 and fiscal 2021:

1Includes business-to-business net revenues within each brand.

2Primarily consists of net revenues from Rejuvenation, our international franchise operations and Mark and Graham.

Comparable Brand Revenue

Comparable brand revenue includes comparable e-commerce sales, including through our direct-mail catalog, and store sales, as well as shipping fees, sales returns and other discounts associated with current period sales. Comparable stores are defined as permanent stores where gross square footage did not change by more than 20% in the previous 12 months, and which have been open for at least 12 consecutive months without closure for more than seven days within the same fiscal month. Comparable stores that were temporarily closed during fiscal 2021 due to COVID-19 were not excluded from the comparable brand revenue calculation. Outlet comparable store net revenues are included in their respective brands. Business-to-business revenues are included in comparable brand revenue for each of our brands. Sales to our international franchisees are excluded from comparable brand revenue as their stores and e-commerce websites are not operated by us. Sales from certain operations are also excluded until such time that we believe those sales are meaningful to evaluating their performance. Additionally, comparable brand revenue growth for newer concepts is not separately disclosed until such time that we believe those sales are meaningful to evaluating the performance of the brand.

1Comparable brand revenue includes business-to-business revenues within each brand.

2Total comparable brand revenue growth includes the results of Rejuvenation and Mark and Graham.

30

Table of Contents

RETAIL STORE DATA

1 Retail store data for fiscal 2021 includes stores temporarily closed due to COVID-19. All stores were reopened as of the end of fiscal 2021.

COST OF GOODS SOLD

1Includes occupancy expenses of $785.4 million and $728.0 million in fiscal 2022 and fiscal 2021, respectively.

Cost of goods sold includes cost of goods, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight expenses, freight-to-store expenses and other inventory related costs such as replacements, damages, obsolescence and shrinkage. Occupancy expenses consist of rent, other occupancy costs (including property taxes, common area maintenance and utilities) and depreciation. Shipping costs consist of third-party delivery services and shipping materials.

Our classification of expenses in cost of goods sold may not be comparable to other public companies, as we do not include non-occupancy-related costs associated with our distribution network in cost of goods sold. These costs, which include distribution network employment, third-party warehouse management and other distribution-related administrative expenses, are recorded in selling, general and administrative expenses ("SG&A").

Fiscal 2022 vs. Fiscal 2021

Cost of goods sold increased $382.7 million, or 8.3%, compared to fiscal 2021. Cost of goods sold as a percentage of net revenues increased to 57.6% from 56.0% in fiscal 2021. This increase was primarily driven by (i) higher input costs as we absorbed higher product costs, ocean freight, detention and demurrage due to the impact of supply chain disruption and global inflation pressures, (ii) higher outbound customer shipping costs due to out-of-market shipping and shipping multiple times for multi-unit orders, and (iii) higher occupancy costs resulting from incremental costs from our new distribution centers on the east and west coasts to support our long-term growth, which was partially offset by our retail store optimization initiatives.

31

Table of Contents

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

SG&A consists of non-occupancy-related costs associated with our retail stores, distribution and manufacturing facilities, customer care centers, supply chain operations (buying, receiving and inspection) and corporate administrative functions. These costs include employment, advertising, third-party credit card processing and other general expenses.

Fiscal 2022 vs. Fiscal 2021

SG&A increased $0.5 million and remained relatively flat compared to fiscal 2021. SG&A as a percentage of net revenues decreased to 25.1% from 26.4% for fiscal 2021. This decrease in rate was primarily driven by the leverage of employment costs and advertising expenses from overall cost discipline and adjusted incentive compensation commensurate with business performance.

INCOME TAXES

The effective income tax rate was 24.8% for fiscal 2022 and 22.4% for fiscal 2021. Compared to fiscal 2021, the increase in the tax rate is primarily due to less excess tax benefit from stock-based compensation in fiscal 2022, the return to provision difference between the two fiscal years, the expiration of the statutes of limitation related to uncertain tax positions in fiscal 2021 and the change in permanent reinvestment assertion on Canadian earnings in fiscal 2022.

Since the Tax Cuts and Jobs Act of 2017, we have elected not to provide for income taxes with respect to the earnings of Canada after fiscal 2017. In the second quarter of fiscal 2022, we assessed the overall forecasted cash needs and financial position of our foreign subsidiaries, and management decided to no longer assert its intent to indefinitely reinvest undistributed earnings in Canada. As a result of this change in assertion, we recorded $2.4 million of tax expense mainly related to Canadian withholding taxes.

The Inflation Reduction Act, enacted on August 16, 2022, includes a new 15% minimum tax on “adjusted financial statement income” beginning with the Company’s fiscal year 2023, and a new 1% excise tax on stock repurchases after December 31, 2022, which will be included in the acquisition cost of treasury stock recorded within stockholders' equity. While these tax law changes had no immediate effect in fiscal 2022 and are not expected to have a material adverse effect on our results of operations going forward, we will continue to evaluate its impact as further information becomes available.

LIQUIDITY AND CAPITAL RESOURCES

Material Cash Requirements

We are party to contractual obligations involving commitments to make payments to third parties in the future. Certain contractual obligations are reflected on our Consolidated Balance Sheet as of January 29, 2023, while others are considered future obligations. Our material cash requirements as of January 29, 2023 include the following contractual obligations and commitments arising in the normal course of business:

•Our operating leases had fixed lease payment obligations, including imputed interest, of $1.7 billion, with $308.3 million payable within 12 months. See Note E to our Consolidated Financial Statements for amount outstanding as of January 29, 2023 related to operating leases.

•Our purchase obligations consist primarily of open purchase orders to purchase inventory as well as commitments for products and services used in the normal course of business. As of January 29, 2023, our purchase obligations were approximately $981.0 million, with $910.0 million expected to be settled within 12 months.

In addition, we had $37.1 million of unrecognized tax benefits recorded in our accompanying Consolidated Balance Sheet as of January 29, 2023, for which we cannot make a reasonably reliable estimate of the amount and period of payment. See Note D to our Consolidated Financial Statements for information related to income taxes.

We are party to a variety of contractual agreements under which we may be obligated to indemnify the other party for certain matters. These contracts primarily relate to commercial matters, operating leases, trademarks, intellectual property and financial matters. Under these contracts, we may provide certain routine indemnifications relating to representations and warranties or personal injury matters. The terms of these indemnifications range in duration and may not be explicitly defined. Historically, we have not made significant payments for these indemnifications. We believe that if we were to incur a loss in any of these matters, the loss would not have a material effect on our financial condition or results of operations.

See Note I to our Consolidated Financial Statements for further information related to our commitments and contingencies.

32

Table of Contents

Dividends

In fiscal 2022 and fiscal 2021, total cash dividends declared were approximately $216.3 million, or $3.12 per common share, and $199.4 million, or $2.60 per common share, respectively. In March 2023, our Board of Directors authorized a 15% increase in our quarterly cash dividend, from $0.78 to $0.90 per common share, subject to capital availability. Our quarterly cash dividend may be limited or terminated at any time.

Stock Repurchase Program

See section titled “Stock Repurchase Program” within Part II, Item 5 of this Annual Report on Form 10-K for further information.

Liquidity Outlook

We believe our cash on hand, cash flows from operations, and our available credit facilities will provide adequate liquidity for our business operations as well as capital expenditures, dividends, share repurchases, and other liquidity requirements associated with our business operations over the next 12 months. We are currently not aware of any other trends or demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, our liquidity increasing or decreasing in any material way that will impact our capital needs during or beyond the next 12 months.

Sources of Liquidity

As of January 29, 2023, we held $367.3 million in cash and cash equivalents, the majority of which was held in interest-bearing demand deposit accounts and money market funds, and of which $81.2 million was held by our international subsidiaries. As is consistent within our industry, our cash balances are seasonal in nature, with the fourth quarter historically representing a significantly higher level of cash than other periods.

Throughout the fiscal year, we utilize our cash resources to build our inventory levels in preparation for our fourth quarter holiday sales. Our largest source of operating cash flows is cash collections from the sale of our merchandise throughout the year. In fiscal 2023, we plan to use our cash resources to fund our inventory and inventory-related purchases, employment related-costs, advertising and marketing initiatives, rental payments on our leases, stock repurchases and dividend payments, property and equipment purchases, and the payment of income taxes.

In addition to our cash balances on hand, we have a credit facility (the "Credit Facility") which provides for a $500 million unsecured revolving line of credit (the “Revolver”). Our Revolver may be used to borrow revolving loans or to request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders, at such lenders’ option, to increase the Revolver by up to $250 million to provide for a total of $750 million of unsecured revolving credit.

Currently, the interest rate applicable to the Revolver is variable and may be elected by us as: (i) the LIBOR plus an applicable margin based on our leverage ratio ranging from 0.91% to 1.775% or (ii) a base rate as defined in the Credit Facility, plus an applicable margin based on our leverage ratio ranging from 0% to 0.775%. However, as a result of the future cessation of LIBOR, our interest rate will change in fiscal 2023 in accordance with the Credit Facility. On the earliest of (i) the date that LIBOR rates permanently or indefinitely cease to be provided, (ii) June 30, 2023 or (iii) the early opt-in effective date which is determined by us, the replacement benchmark rate will be determined.

During fiscal 2022, we had no borrowings under our Revolver. Additionally, as of January 29, 2023, issued but undrawn standby letters of credit of $11.2 million were outstanding under our Revolver. The standby letters of credit were primarily issued to secure the liabilities associated with workers’ compensation and other insurance programs.

Our Credit Facility contains certain restrictive loan covenants, including, among others, a financial covenant requiring a maximum leverage ratio (funded debt adjusted for operating lease liabilities to earnings before interest, income tax, depreciation, amortization and rent expense), and covenants limiting our ability to incur indebtedness, grant liens, make acquisitions, merge or consolidate, and dispose of assets. As of January 29, 2023, we were in compliance with our financial covenants under our credit facilities and, based on our current projections, we expect to remain in compliance throughout the next 12 months.

Letter of Credit Facilities

We have three unsecured letter of credit reimbursement facilities for a total of $35 million. Our letter of credit facilities contain covenants that are consistent with our Credit Facility. Interest on unreimbursed amounts under our letter of credit facilities accrues at a base rate as defined in the credit facility, plus an applicable margin based on our leverage ratio. As of January 29, 2023, the aggregate amount outstanding under our letter of credit facilities was $0.5 million, which represents only a future commitment to fund inventory purchases to which we had not taken legal title. On August 19, 2022, we renewed all three of our letter of credit facilities on substantially similar terms. Two of the letter of credit facilities totaling $30 million mature on August 19, 2023, and the latest expiration date possible for future letters of credit issued under these facilities is January 16, 2024. One of the letter of credit facilities totaling $5 million matures on September 30, 2026, which is also the latest expiration date possible for future letters of credit issued under the facility.

33

Table of Contents

Cash Flows from Operating Activities

For fiscal 2022, net cash provided by operating activities was $1.1 billion compared to $1.4 billion in fiscal 2021. For fiscal 2022, net cash provided by operating activities was primarily attributable to net earnings adjusted for non-cash items, partially offset by higher spending on merchandise inventories as a result of our efforts to improve our in-stock position as well as accounts payable. Net cash provided by operating activities compared to fiscal 2021 decreased primarily due to decreases in accounts payable and accrued expenses and other liabilities.

Cash Flows from Investing Activities

For fiscal 2022, net cash used in investing activities was $354.0 million compared to $226.2 million in fiscal 2021 and was primarily attributable to purchases of property and equipment related to technology and supply chain enhancements.

Cash Flows from Financing Activities

For fiscal 2022, net cash used in financing activities was $1.2 billion compared to $1.5 billion in fiscal 2021 and was primarily attributable to the repurchases of common stock and payment of dividends. Net cash used in financing activities for fiscal 2022 decreased compared to fiscal 2021 primarily due to the repayment of debt in the fiscal 2021 that did not recur in fiscal 2022.

IMPACT OF INFLATION

While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we have experienced varying levels of inflation, resulting in part from various supply chain disruptions, increased shipping and transportation costs, increased product costs, increased labor costs in the supply chain and other disruptions caused by the COVID‐19 pandemic and the uncertain economic environment. Global trends, including inflationary pressures, are weakening customer sentiment, negatively impacting consumer spending behavior and slowing down consumer demand for our products. However, our unique operating model and pricing power helped mitigate these increased costs during fiscal 2022. We cannot be assured that our results of operations and financial condition will not be materially impacted by inflation in the future. For information on risks, please see “Risk Factors” in Part I, Item 1A.

CRITICAL ACCOUNTING ESTIMATES

Our Consolidated Financial Statements requires us to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. These estimates are evaluated on an ongoing basis and are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ from these estimates.

Merchandise Inventories

The significant estimates used in our inventory valuation are obsolescence (including excess and slow-moving inventory and lower of cost or net realizable value reserves) and estimates of inventory shrinkage. We reserve for obsolescence based on historical trends of inventory sold below cost and specific identification.

The reserves for shrinkage are recorded throughout the year based on historical shrinkage results, cycle count results within our distribution centers, expectations of future shrinkage and current inventory levels, and are therefore subject to uncertainty. Actual shrinkage is recorded at year-end based on the results of our cycle counts and year end physical inventory counts, and can vary from our estimates recorded throughout the year due to such factors as changes in operations, the mix of our inventory (which ranges from large furniture to small tabletop items) and execution against loss prevention initiatives in our stores, distribution facilities and off-site storage locations, and with our third-party warehouse and transportation providers. Accordingly, there is no material shrinkage reserve at year-end. Historically, actual shrinkage has not differed materially from our estimates.

Our obsolescence and shrinkage reserve calculations contain estimates that require management to make assumptions and to apply judgment regarding a number of factors, including market conditions, the selling environment, historical results and current inventory trends. We have made no material changes to our assumptions included in the calculations of the obsolescence and shrinkage reserves throughout the year. In addition, we do not believe a 10% change in our inventory reserves would have a material effect on our net earnings. As of January 29, 2023 and January 30, 2022, our inventory obsolescence reserves were $24.7 million and $14.0 million, respectively.

Long-lived Assets

Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.

We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. Our impairment analyses determine whether projected cash flows from operations are sufficient to recover the carrying value of these assets. The asset group is comprised of both property and equipment and operating lease right-of-use assets. Impairment may result when the carrying value of the asset or asset group exceeds the estimated undiscounted future cash flows over its remaining useful life. Our estimate of

34

Table of Contents

undiscounted future cash flows over the lease term is based upon our experience, the historical operations and estimates of future profitability and economic conditions. The estimates of future profitability and economic conditions require estimating such factors as sales growth, gross margin, employment costs, lease escalations, inflation and the overall economics of the retail industry, and are therefore subject to variability and difficult to predict. For right-of-use assets, we determine the fair value of the assets by using estimated market rental rates. These estimates can be affected by factors such as future results, real estate supply and demand, closure plans, and economic conditions that can be difficult to predict. Actual future results may differ from those estimates. If a long-lived asset is found to be impaired, the amount recognized for impairment is equal to the excess of the asset or asset group’s net carrying value over its estimated fair value.

During fiscal 2022, we recognized impairment charges of $3.3 million related to the impairment of property and equipment and $2.6 million related to the impairment of operating lease right-of-use assets, due to lower projected revenues and fair market rental values resulting from underperforming stores in Australia, and we also recognized impairment charges of $9.7 million related to the impairment of property and equipment associated with Aperture, a division of our Outward, Inc. subsidiary, due to these assets not being recoverable in light of projected future cash flows, all of which is recognized within SG&A. During fiscal 2021, no impairment charges were recognized. During fiscal 2020, we recognized asset impairment charges of approximately $19.2 million related to property and equipment and $7.9 million related to right-of use assets for our retail stores, which is recognized within SG&A.

Leases

The significant estimates used in accounting for our leases relate to the incremental borrowing rate used in the present value of lease obligations calculation. As our leases generally do not provide information about the rate implicit in the lease, we utilize an estimated incremental borrowing rate to calculate the present value of our future lease obligations. The incremental borrowing rate represents the rate of interest we would have to pay on a collateralized borrowing, for an amount equal to the lease payments, over a similar term and in a similar economic environment. We use judgment in determining our incremental borrowing rate, which is applied to each lease based on the lease term. A 50 basis point increase or decrease in the incremental borrowing rate would not have a material impact on the value of our new or remeasured right-of-use assets and lease liabilities. As of fiscal 2022 and fiscal 2021, our incremental borrowing rates were 3.4% and 3.2%, respectively. Many of our leases contain renewal and early termination options. The option periods are generally not included in the lease term used to measure our lease liabilities and right-of-use assets upon commencement, as we do not believe the exercise of these options to be reasonably certain. We remeasure the lease liability and right-of-use asset when we are reasonably certain to exercise a renewal or an early termination option. We use judgment in determining lease classification, including our determination of the economic life and the fair market value of the identified asset. The fair market value of the identified asset is generally estimated based on comparable market data provided by third-party sources.

Income Taxes

We record reserves for our estimates of the additional income tax liability that is more likely than not to result from the ultimate resolution of foreign and domestic tax examinations. The results of these examinations and negotiations with taxing authorities may affect the ultimate settlement of these issues. We review and update the estimates used in the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax examination, upon expiration of statutes of limitation, or upon occurrence of other events. As of January 29, 2023, we had $37.1 million of gross unrecognized tax benefits, of which $31.0 million would, if recognized, affect the effective tax rate. Additionally, we accrue interest and penalties related to these unrecognized tax benefits in the provision for income taxes. As of January 29, 2023 and January 30, 2022, our accruals for the payment of interest and penalties totaled $6.1 million and $5.7 million, respectively. Due to the potential resolution of tax issues, it is reasonably possible that the balance of our gross unrecognized tax benefits could decrease within the next twelve months by a range of $0 to $6.2 million.

In order to compute income tax on an interim basis, we estimate what our effective tax rate will be for the full fiscal year and adjust these estimates throughout the year as necessary. Adjustments to our income tax provision due to changes in our estimated effective tax rate are recorded in the interim period in which the change occurs. The tax expense (or benefit) related to items other than ordinary income is individually computed and recognized when the items occur. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of our earnings in various taxing jurisdictions or changes in tax law. Our effective tax rates for fiscal 2022 and fiscal 2021 were 24.8% and 22.4%, respectively.

35

Table of Contents